Introduction
Perceptive investors, lenders, as well as some other stakeholders have a major role in conducting fundamental financial analysis in order to ascertain any firm’s financial health prior to settling for some form of investment. In other words, financial analysis is not only important for the business but also for the investors, lenders as well as other stakeholders for the determination of future investments. The financial analysis involves the quantitative scrutiny of the filed financial statements across a specified fiscal period1. One of the methods that are generally used to quantitatively analyze the firms’ finances is the ratio analysis. From the ratio analysis, the firms’ profitability, valuation measures, operational and the general performances are indicated.
In the context of Abu Dhabi Islamic Bank and Abu Dhabi Commercial Bank, investors can only ascertain whether the firms are eligible for investment after the analysis of their financial statements. To determine whether these firms are eligible for future investments and to provide investors with full information on which of the firms have future prospects for business growth and productivity, the computation of profitability, liquidity, risk and solvency ratios have to be performed.
In the analysis, the profitability, liquidity, risk and solvency ratios of Abu Dhabi Commercial Bank and Abu Dhabi Islamic Bank were determined. The financial performances of these firms indicate that both have prospective for future investments. However, for perceptive investors, Abu Dhabi Commercial Bank has more prospect for investment as indicated by its profitability and liquidity measures.
Comparing the financial ratios for each bank
Abu Dhabi Commercial Bank
The profitability ratios
Return on assets
The Return-on-assets is one of the important profitability ratio used by the firms to show their net income as a percentage of assets they hold. Firms use return-on-assets to evaluate their profitability by indicating the amount of profit they have generated from their assets2. In the two financial years, Abu Dhabi Commercial Bank has indicated a decreasing trend in the returns on assets. In other words, the profits the firm has generated on assets have decreased by 0.001 representing 0.0625%. Even though the decrease is not significant, the trend should worry the firm since the ratio shows a decreasing trend in returns on investments.
Return on equity
Return on equity is the net income that is returned as a proportion of the investor’s equity. The investors as well as other stakeholders need to know the returns the firm has generated on the amount of money that has been invested. The returns generated on the amount of money invested can only be indicated through return on equity ratio. In the case of Abu Dhabi Commercial Bank, the firm has improved on its ability to turn the capital into profits. The rations indicate an increasing trend in the firm’s returns on equity. Even though the ratios were not significantly high, the increasing trend shows a positive sign on the ability of the firm to utilize its capital to earn profits.
The profits expense ration
The profit expenses ratio indicates how the firm leverages its expenses against the profits. In fact, the ratio shows how the firm is efficient in its operations in order to reduce expenses. Moreover, the ratio indicates cost effectiveness of the firm in its operations. In addition, the ratio indicates the level at which the firm can generate returns with the current expenses. The profit expenses ration of Abu Dhabi Commercial Bank indicates a decreasing trend from 2011 financial year to 2012 financial year. The decreased ratio either can be because of increased expenses or reduced profits.
Liquidity Ratios
Cash deposit ratio
The ratio indicates the firms’ liquidity by measuring the mount the firm holds against the deposits. The cash deposit ration of the firm shows an increasing trend from the previous financial year. The increase in the ratio indicates that the firm is in a better position to settle its short-term debts.
Loan deposit ratio
The capability of the firm to settle its short-term debt obligations are indicated by the loan deposit ratio. The loan deposit ratio indicates the amount the firm holds in terms of loans and deposits. The firm’s loan deposit ratio has increased significantly from the previous financial year. The indication is that the firm has increased its long-term loans than the deposits.
Current assets and current to asset ratios
The tendency in the rations provides an overview on how the firm is dealing with its short-term loans. Moreover, decreased current ratio from the previous year shows that creditors will have to wait before their debts are settled. However, the firm shows an increasing trend in the current to asset ratio. The increased current to asset ratio indicates that the firm is liquid and can utilize its current assets to settle its short-term debt obligations.
Risk and solvency ratios
All the ratios of the firm indicate positive improvements from the previous financial year. The significant improvement is observed in the debt to total assets ratio, which indicates the bank’s financial strength to pay debts.
Abu Dhabi Islamic Bank
The profitability ratios
The bank indicates mixed trends in the profitability ratios. In terms of return on assets, Abu Dhabi Islamic Bank has indicated a decreasing trend in the last two financial years. In other words, the profits the firm has generated on assets have decreased significantly. Even though the decrease is not large, the trend should be noteworthy to the firm since it shows decreasing trend in returns on investments. However, there is an increasing trend in the firm’s returns on equity. The increasing trend shows that the firm has improved on its ability to turn the capital into profits. Moreover, the increasing trend shows a positive sign on the ability of the firm to utilize its capital to earn profits. The decreasing trend is also observed in the profits expense ratio. As in the case of Abu Dhabi Commercial Bank, the decreased ratio either can be because of increased expenses or reduced profits.
Liquidity Ratios
Similar to the profitability ratios, the bank shows mixed trends in its liquidity ratios. The cash deposit ratio that indicates the firms’ liquidity has shown a decreasing trend from the previous financial year. The decrease in the ratio indicates that the firm is not in a better position to settle its short-term debts. Similar decreasing trend is also observed in loan deposit ratio. In fact, the decrease in loan deposit ratio is quite significant. The meaning is that the capability of the firm to settle its short-term debt obligations is significantly reduced. The loan deposit ratio indicates the amount the firm holds in terms of loans and deposits.
However, the trends in the current ratio and the current to asset proportions are quite positive. Improvements in the current ratio imply that the firm will be able to pay depositors. In addition, the increased current and current asset ratios from the previous year show that the firm will take shorter time to meet its daily debt obligations. Moreover, the increased current to asset ratio indicates that the firm is liquid and can utilize its current assets to settle short-term debts.
Risk and solvency ratios
All the ratios of the bank within this category indicate a decreasing trend from the previous financial year. The significant decrease is observed in the loans to deposit ratio indicating the bank’s financial incapability to settle its loans using the deposits.
Comparing the financial ratios for Abu Dhabi Commercial Bank and Abu Dhabi Islamic Bank
Profitability ratios
Return on assets
Both firms have reasonable records on the returns on assets in the last two years. Abu Dhabi Commercial Bank has higher returns on assets compared to that of Abu Dhabi Islamic Bank. Both firms have also recorded decreasing trend in the returns on assets. The decrease could be attributed to shocks experienced in the industry. Moreover, the decreasing trends in the return on assets in the last two years are in equal measure.
Return on equity
Abu Dhabi Commercial Bank show higher return on equity than Abu Dhabi Islamic Bank though Abu Dhabi Islamic Bank show a decreasing trend while Abu Dhabi Commercial Bank indicate an increasing trend in the last two financial years. Therefore, investors are likely to get more returns on their investment particularly on Abu Dhabi Commercial Bank. Compared with the industry average, both firms are above average. Further, the findings indicate greater opportunities for higher returns on investments.
Profit expenses ratio
Both firms indicate decreasing trends in the ratio. In fact, the profit expense ratio shows how the firm is efficient in its operations in order to reduce expenses. The decreasing trends indicate that the firms are not cost effective in their operations. In addition, the ratio indicates the level at which the firm can generate returns with the current expenses. As indicated, the decreased ratios either can be attributed to increased expenses or reduced profits.
Liquidity ratios
Current ratios
In this case, both firms show increasing trends in their current ratios. However, Abu Dhabi Commercial Bank indicate significant increasing trend in the proportions contrary to improvements observed in Abu Dhabi Islamic Bank. Even though the current ratio of Abu Dhabi Islamic Bank has slowly increased in the last financial year, it can still take shorter time to meet its debt obligations as compared to Abu Dhabi Commercial Bank. The current ratios of the two firms indicate that they have no difficulties in meeting their current debt obligations.
Current to asset ratios
The trends indicate improvements in the current to asset ratio. The increased trends indicate that the firms are capable of meeting their short-term debts. Contrary to that of Abu Dhabi Islamic Bank, the current to asset ratios of Abu Dhabi Commercial Bank increased significantly in the last two financial years. The indication is that Abu Dhabi Commercial Bank will be in a position to ensure that its future short-term debt requirements are met.
Risk and solvency ratios
Debt to equity ratio
A debt that bears interests is what is being considered in this ratio. The debt that bears interest normally takes more than one year to be repaid. Therefore, it is the long-term loans to shareholders-equity that both firms will use to measure the proportion of their equity being financed by debt. Increased long-term debt to equity of Abu Dhabi Commercial Bank means that the firm is using much debt to finance its operations. In essence, Abu Dhabi Islamic Bank is more stable as it uses less of its debts to finance most of the operations.
Debt to asset ratio
Normally, long-term debt is used in this ratio. The ratio is a measure on how long-term loans are used to fund the operations of the firm. Long-term debts consist of loans repayable after one year. The ratio provides a general appraisal of Abu Dhabi Commercial Bank and Abu Dhabi Islamic Bank financial positions. Moreover, the ratio is used to determine the quantity of outstanding loans that can be recovered by the banks. The decreasing trend in the metrics of Abu Dhabi Islamic Bank is a sign that the firm is progressively meeting its long-term debt. Moreover, Abu Dhabi Commercial Bank ratios of long-term debt to the total assets have improved from the last financial years. The indication is that the firm has offset most of its long-term debt obligations.
The interpretation of the results
The profitability ratios detail how the firms have used limited resources to be able to generate revenues, which in effect add to the shareholders value3. For the firm to survive, devising effective and growth-focused long-term strategies for possible revenue generation remains indispensable. Long-term profits are not only essential for the survivability of the firm but also to the benefit of the shareholders who normally get the profits in form of dividends. Higher profits are also good indicators for investors especially those who value quick returns for their investments.
Investment valuation margins including return on assets, returns on equity and profit expense ratios are essential in investment decisions. Moreover, in any typical firm’s productivity analysis, return on assets and the return on equity show the effectiveness of the firms in the use of the employed resources in order to generate income4. The ratios are the most vital for the investors since much of the investments are in form of assets, equity, or capital employed in the form of borrowings.
The firms’ capabilities to meet their daily operations measure their financial soundness. In other words, the capability of the firm to ensure that both short-term and long-term debtors are paid within the required period. The responsibilities of the firm to pay debtors are majorly determined by liquidity ratios. In most cases, firms create a balance between the most liquid-assets such as cash to the immediate liabilities. Generally, greater liquid-asset coverage to current obligations ratio is better for the firms. The greater ratio indicates that the firms can easily pay for the due debt within the shortest period and can still meet the ongoing operations.
On the contrary, lower coverage ratio shows that the firms are incapable of meeting its short-term needs and at the same have complications in managing its operations. The most commonly used liquidity ratios are the current ratio and current to asset ratios.
Most importantly, the firms’ long-term debt responsibilities are determined by the solvency ratios. As indicated in the analysis, the solvency ratios show varied trends. In some instances, the solvency proportions show decreasing trends, which are not healthy for the firms. Essentially, the ratios are calculated using the net profits though non-cash depreciation expenses are deducted. The results are then compared with total debt obligations5. Besides, the ratios make available dimensions of the possibility of the businesses to keep on meeting their liabilities. Moreover, the ratios should be above 0.25 in order for the firm to be considered financially sound. In general, in the circumstances that the ratios are below 0.25, the firm will not be able to pay the debtors.
However, it is also important to note that the industry in which these firms are operating in is highly volatile. Therefore, these rations are not the ultimate measure of their performance for investment decisions. Besides, the valuation rations that take into consideration the firms share equities have not been considered. In addition, some of these ratios must be compared with industrial average’s to determine exact measure to draw conclusions.
Summary and conclusion
As can be drawn from the analysis, the solvency ratios indicate Abu Dhabi Commercial Bank and Abu Dhabi Islamic Bank strong points concerning their ability to offset the cost of prospective long-term investments. From the trend analysis, Abu Dhabi Islamic Bank has come out to be strongest firm. As a result, the firm is financially stable and viable for future investments and growth in terms of its equity. The profitability ratios measure the firm’s growth in returns. As drawn from the trend analysis, the growth in returns for Abu Dhabi Commercial Bank is higher though fluctuating. However, it is expected to increase in the coming years.
Concerning the liquidity ratios, the trend indicates decreasing and fluctuating results in both firms. The decreases could be attributed to explanatory short-term consequences. Generally, Abu Dhabi Commercial Bank has come out to be the best firm in terms of prospective long-term investments.
References
Gibson, C, Financial reporting & analysis: using financial accounting information, Cengage Learning, Farmington Hills, 2010. Web.
Guerard, J, Quantitative corporate finance, Springer, Chicago, 2007. Web.
Latifa, M, Islamic banking financial analysis, Edward Elgar, Cheltenham, UK, 2001. Web.
Lee, A, Financial analysis, planning & forecasting theory and application, World Scientific, New Jersey, 2009. Web.
Appendix
Computation of Ratios
Footnotes
- A Lee, Financial analysis, planning & forecasting theory and application, World Scientific, New Jersey, 2009, p.345. Web.
- J Guerard, Quantitative corporate finance, Springer, Chicago, 2007, p.48. Web.
- Ibid.
- C Gibson, Financial reporting & analysis: using financial accounting information, Cengage Learning, Farmington Hills, 2010, p.37. Web.
- M Latifa, Islamic banking financial analysis, Edward Elgar, Cheltenham, UK, 2001,112. Web.